Archive for the ‘S-Corporation’ Tag

Do I Need to Set up an LLC or Incorporate?

Originally published in the Cedar Street Times

October 3, 2014

Two weeks ago I discussed some of the pitfalls of using an online service to help you set up an entity such as an LLC, C-Corporation, or S-Corporation for your business.  In a nutshell, you really need tailored advice from an accountant and an attorney to address your circumstances and you should use an attorney to properly set everything up.  I have found that people that utilize these services generally do not have a good understanding of what they did and why, and they don’t know much about their ongoing responsibilities, the importance of carrying them out, or the consequences of failing to do so.

Now I am going to turn the tables and ask you why you think you need a formal entity at all?  When I say this I am thinking about small businesses getting started.  If your accounting and legal advice is from family or friends, hopefully they actually are accountants and business attorneys and reviewing your WHOLE situation.  Or maybe you read something online – maybe even an article like this!  Be careful what you read!

My personal feeling is that there are a lot of small businesses out there that have set up entities prematurely, and have entangled themselves in a lot of extra cost, record keeping, and administrative hassle for very little benefit.

The vast majority of people setting up entities for small businesses do it because of perceived liability protection for their personal assets.  Some do it for certain circumstances that can lead to tax benefits, and others do it in rare circumstances where a major customer requires it.

It is important to understand there is no bullet proof solution when it comes to shielding yourself from liability.  There is almost always a way to spoil a good plan.  Legions of lawyers make their living at this.  Layers of protection are often implemented to mitigate the risk of chinks in your armor.  For instance have an entity and also having insurance would be a good example.

It is also important to understand that entities do not protect you from all forms of claims.  For instance, professionals cannot be shielded by an entity for acts of malpractice.  Malpractice insurance, however, could cover you.

If you do not respect the entity by following all the rules of corporations, s-corporations, or LLCs promulgated by various government authorities, then if there is a lawsuit, the courts could say, “You didn’t respect the entity, so why should we?”  They could look right through your entity and allow a creditor to go after your personal assets.

Small businesses are at a much higher risk for this since they generally don’t have a legal department trying to keep up with all the details!  I have seen small businesses that have gone through the hassle and expense of setting up corporations, filing tax returns and paying the California Franchise Tax each year and yet they have never held a corporate meeting or elected officers, never recorded any corporate minutes (and even if it is just you wearing all hats, you can’t ignore these things!), and treated the bank accounts of the company like an extension of their personal checking account.  And all the while they were thinking they had solid liability protection because they were a corporation…uhh no.  The devil is in the details as it is said!

Besides the initial cost of setting up an entity properly which could run two or three thousand dollars or more, you then have to file separate business tax returns, file an informational filing with the Secretary of State, possibly have an attorney draft a document or two each year, have better accounting for the tax returns (true double-entry accounting which includes an accurate balance sheet in addition to the profit and loss statement), and then you get the privilege of paying California at least $800 a year whether you make a dime or not.  So you have at least another couple thousand dollars each year of ongoing costs (more if you need to hire a bookkeeper when you find out that QuickBooks actually requires a fairly good amount of accounting knowledge to operate it properly.)

If the inherent risk of the business is relatively small or moderate, and especially if you are starting very small and do not even know if the business is going to be successful, then I think you need to carefully way the benefits and costs.  Could you just carry really good insurance and mitigate your risk to an acceptable level?  Do you need the additional layer of protection?  You can always incorporate or set up an LLC later.  Do you have employees, and what amount of risk do they expose you to?  Are they driving vehicles a lot for your business?  Or do you have rental property with lots of tenants?  Maybe you are a free-lance graphic artist designing business cards remotely from your home – not much risk there!  What are you trying to protect anyway – maybe the bulk of your personal assets you have would be considered exempt assets from creditors already? Although attorneys are generally risk-averse because they see all the things that can go wrong, and therefore would prefer to set up an entity, I think these types of discussions can be had with them and really question if it is right to set up an entity for your business for liability reasons.

Taxwise, there can be benefits to setting up an entity, depending on your circumstances, but it is rarely a driving force in and of itself for most small businesses.  The most common one people ask about deals with reducing self-employment taxes for the owner of an S-corporation.  There are ways this can be successful, but it is an issue that is in jeopardy of being eliminated.  It also has the drawback of possibly reducing your future Social Security benefits – although our government will probably beat you to the punch on that one anyway.

If you read this article and think, gee, I am not sure I really need the entity I have – do not just ignore the entity and pretend it doesn’t exist anymore!  Besides getting the proper tailored advice for you, you generally must properly dissolve it, or you will be plagued with continuing mandates for tax returns as well as Franchise Tax fees to California.  (There are limited circumstances where you can just walk away.)

In summary, get competent advice from an accountant and an attorney in light of YOUR facts and circumstances before jumping into an entity.  And question its necessity if you are small or if your business has low or moderate inherent risk and you have access to insurance that could protect you sufficiently.

Prior articles are republished on my website at www.tlongcpa.com/blog.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Forming a Business Entity

Originally published in the Cedar Street Times

September 19, 2014

Over the years, I have had many appointments with new and existing clients that are starting a small business for the first time.  We usually spend about an hour or so going through the basics of what to expect and be aware of: we cover things like self-employment taxes, tax estimates, business property tax statements, employees, insurance, sales tax, fictitious business name registration, business bank accounts, EINs, business licenses, etc.  One of the first things we talk about, however, is entity selection.  In other words, are you going to operate as a sole proprietorship, or will you form an LLC, S-corporation, C-corporation, partnership, etc.

Unfortunately, there are many people out there who pull the trigger early on entity selection based on something they hear from friends or find on the internet prior to getting tailored professional advice.  My feeling is that you really want to have a discussion about your particular situation with your accountant to provide input on the tax and accounting related issues and a business attorney to weigh in on liability, and other legal related issues before you get started.  The attorney should form the entity if you choose to operate other than as a sole proprietorship.

There are too many pitfalls, and I know there are many people out there that have made the wrong choice or, even worse, are operating with a presumption of liability protection when they have none because they did not properly form or respect the formalities of the entity.  Opposing counsel could have a victory on their hands if you failed to prepare annual corporate minutes, for instance. “Piercing the corporate veil” could suddenly enter your lexicon.

Online companies attempt to make it cheap and quick to form an entity for you, but I can tell you from my experience that many of the entities formed this way are later corrected or scrapped and redone by an attorney if one is hired to review it.  One of the problems, is that you have to be an attorney to render legal advice, and since it is rare for online companies to have attorneys for you to discuss your situation with, you may not choose the best entity or get all the language in your formation documents that you need.

Online companies also have difficulty conveying in an effective manner the important things to keep up with and staying in touch regarding these issues.  Many of the people who have used online services show up in my office with a fat binder that was shipped to them in the mail of which they have very little understanding; often has blanks that were never filled out; and has been collecting dust on the shelf.

I also hear from a fair number of these people that get notices from California requesting tax returns and a bunch of money for entities the taxpayer stopped operating years ago or maybe never even started aside from setting up the entity.  Unfortunately no one was there to advise them on how to properly close the entity.  The taxpayer often thinks that if they stop operating or decide not to go ahead with the business that they are done.  It doesn’t work this way.  I have even had people that formed an entity online and were shocked that they would have an $800 minimum fee to California each year.

There is a general push from many directions for people to establish entities for their small businesses these days.  In two weeks we will discuss the merits (or not) of this presumption.

Prior articles are republished on my website at www.tlongcpa.com/blog.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Can’t Finish Returns by October 15 Deadline?

Originally published in the Cedar Street Times

October 5, 2012

If you placed your 2011 personal tax returns on extension, you have 10 days left to complete the returns and get them filed.  This is especially important if you did not withhold enough tax or make enough estimated tax payments during the year to cover your tax liability that was technically due on April 17.  Penalties are assessed based on the unpaid balance of tax that was due on that date.  There are several penalties assessed, but the hefty penalty is the late filing penalty which equates to five percent of your unpaid tax as of April 17 for each month or part of a month the return is late (capped at 25 percent).

In the past, I have had problematic situations where a client did not receive tax documents until after October 15.  This is sometimes seen when a client is invested in a partnership or has an interest in an S-Corporation or LLC and that entity is filing their returns late – causing all the others to be late as well.  There are even situations when other entities are filing timely and it can cause you to be late.  An example of this would be if you were a beneficiary of an irrevocable trust.  These types of trusts generally have the same due dates that your personal returns do – April 15, with a six month extension to October 15.  What if the trust is completed at the end of the day on October 15?  Will the beneficiary be able to get their K-1 tax document and provide to their accountant to finish before midnight!!  Maybe not!

So what do you do if you still cannot file by October 15?  Is there any hope?  There are some specific exceptions for military service members and taxpayers working abroad, but if you do not qualify for those exceptions, what then?  One option would be to wait until the information is received and then file the return requesting penalty relief for reasonable cause.  This is a tough row to hoe in actuality, because the IRS places a high degree of responsibility on the taxpayer:  I can almost guarantee you that what you feel is reasonable will not be the same as what the IRS feels is reasonable!  You will be categorized as delinquent from the outset, and then you will start on the defensive.

A better solution in many cases would be to go ahead and file a tax return with the information available and your best estimate of any missing information.  (There are provisions in the code that allow for estimates under certain circumstances.)  A statement should be included with the return explaining the situation and the efforts made to obtain the information.  You should also state the intent to amend the return if materially different from the actual information when it is available.  This would prevent a late filing penalty from being assessed, and you would be categorized as timely filed unless the return is challenged by audit.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.